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Risk maturity and sustainable risk financing

20 December 2016

The JLT Life Science 2016 Conference was our ninth. Held at the Savill Court Hotel & Spa near Windsor, it gave risk managers and chief executives in the industry as well as insurers an experts-eye view into a variety of key topics. The discussion on risk maturity and the role of captives produced some interesting observations.

Recommended

Should we take more risk? And how can we make risk financing more efficient?

Risk managers are increasingly looking at developing or evolving their risk financing strategy to align with corporate goals. That means showing the value and effectiveness of risk financing options to people who may not understand captives or alternative risk transfer techniques.

There are some important fundamental ingredients to a risk financing strategy: talk to key stakeholders (including the CFO), develop a corporate risk profile, consider optimum corporate retention(s), analyse realistic options for financing retained risk, consider how to manage volatility, develop solutions with selected (re)insurers, and test for compliance. And you have to articulate all that to senior management, probably in a single meeting.

For most mid-sized to large multinationals a captive makes sense; if a captive can help manage and reduce the cost of risk then it’s in shareholders’ interests to consider. There’s a strong case for putting captives at the centre of the risk financing strategy and placing or consolidating all insurable risk there. By putting risk into a captive, a company gains the benefit of a diversified portfolio whilst being able to access the specialist market for the catastrophic risk and to manage residual volatility.

In short, extreme events should be kept on the balance sheet, as a risk shareholders should bear, with captives covering the lower-impact but more frequent risks. Bundling all these risks together in a portfolio is hugely helpful, and could mean that you buy less insurance.

Issues such as Brexit and base erosion profit shifting (BEPS) are, of course matters for consideration. The OECD report on BEPS touches on captives but shows little sign of really understanding them. It is clearly important that risk transfer must be demonstrable, that premiums are held at arm’s length and are commercially verifiable and that profits enjoyed by the captive are commensurate with the capital and employees. Red flags for captive owners would include situations such as a single subsidiary paying all the premiums on behalf of the corporation or premiums too high for the risk transferred. It is probable that when BEPS has cleared the air, captives may be brought out from under cover and used in a much more efficient way.

JLT has established a Risk Maturity Index which includes risk financing. We use it to help companies identify how mature they want to be and to put project plans in place to help them get there. By doing so we are helping life science risk manager plot a journey in line with their corporate strategy and for their department to add more value to the corporation.

A detailed analysis of new trends in insurance along with other key topics for the industry appear in the recently published reports from the JLT Life Science Conference 2016. To request a copy of the report please email adrian_donald@jltgroup.com.

Jardine Lloyd Thompson Group plc

Jardine Lloyd Thompson Group plc, incorporated and registered in England and Wales. Registered Office at The St Botolph Building, 138 Houndsditch, London, EC3A 7AW. Registered number 1679424. Jardine Lloyd Thompson Group plc is a holding company, some of whose subsidiaries are authorised and regulated by the Financial Conduct Authority.